Today we are going to look at Highland Gold Mining Limited (LON:HGM) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Highland Gold Mining:
0.10 = US$115m ÷ (US$1.3b - US$139m) (Based on the trailing twelve months to June 2019.)
Therefore, Highland Gold Mining has an ROCE of 10%.
See our latest analysis for Highland Gold Mining
Is Highland Gold Mining's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Highland Gold Mining's ROCE appears meaningfully below the 13% average reported by the Metals and Mining industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from Highland Gold Mining's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that, Highland Gold Mining currently has an ROCE of 10% compared to its ROCE 3 years ago, which was 7.5%. This makes us wonder if the company is improving. The image below shows how Highland Gold Mining's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Highland Gold Mining are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Highland Gold Mining.
How Highland Gold Mining's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Highland Gold Mining has current liabilities of US$139m and total assets of US$1.3b. As a result, its current liabilities are equal to approximately 11% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Highland Gold Mining's ROCE
With that in mind, Highland Gold Mining's ROCE appears pretty good. There might be better investments than Highland Gold Mining out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
